Be Greedy When Others are Fearful…

This is an essential part of Warren Buffet’s investment strategy.  The idea is that most investors, as emotional human beings, are wrong when it comes to the stock market.  Interestingly, when the stock market goes down, the number of calls we receive increases.  When the stock market is going up, the phones are quieter.  In down markets, we spend a great deal of time reassuring clients about maintaining the asset allocation that suits them, and not making dramatic changes based on the mood of day or what they see, hear or read in the mainstream media.  It is particularly difficult to maintain a cool head when markets are volatile, and in August we have had several of the most volatile days in the past 50 years (most of them down).  But that is the time when maintaining your composure is even more crucial.

As of this writing, the market is down about 17% from its high in April. It is up about 68% from the low on 3/9/09.  This is referred to as a “correction,” or a decline of more than 10% but less than 20% from a previous peak.  Corrections are not unusual, particularly after a big advance, and have happened on average every 2-3 years since the end of Word War II.

While no two corrections are exactly the same, we can examine historical data to see what has happened in the past.  There is an old saying, which many attribute to Mark Twain, “History doesn’t repeat itself, but it does rhyme.”  The current correction began in late April and has lasted about 3.5 months, with a recent low on the S & P 500 of 1119 set on August 9.  Looking at the average since 1945, corrections have taken about 4 months to go from peak to trough and an additional 4 months to regain their previous peak.

A “bear market”, or decline of more than 20% from a recent high, has historically happened less frequently and had a longer recovery time. We do not believe we are going to experience a bear market, but are fairly close to that level of about 1090 on the S & P 500. 

Yesterday the yield on the 10-year US Treasury Note fell below 2% briefly, the lowest level since the Eisenhower administration in 1954.  Several of the companies that we invest in have current dividend yields of 3% or more, and have raised their dividends each year for 30, 40 or even 55 years.  If asked whether I thought their dividends next year will be higher or lower, I would say higher.  Stock prices eventually follow growth in earnings and dividends (the key word being eventually).  Most economists are forecasting slow but positive economic growth this year, and better growth next year.  We believe stocks, particularly high-quality, dividend-paying companies, are currently very attractively valued relative to bonds and other assets such as gold.  While high-quality companies have lagged somewhat in performance off of the 2009 market bottom, we are seeing many such companies with good and rising dividends and earnings.  We believe that a diversified portfolio of such companies will position our clients well as economic growth continues to improve.

 Bill Hansen, CFA

August 19, 2011

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Stock Market Volatility

It’s been a wild week for stocks.  Not only are stocks down roughly 9% from the end of July as of the close of market August 11, but the pathway down has been marked by extreme volatility.  This month we have experienced six of the 200 most volatile days of the past 50 years.  We have had daily losses of 2.5 – 6.6% and have had daily gains of greater than 4.5%.  These losses were kick started with the political wrangling of the debt ceiling, and were intensified with the ensuingU.S.debt rating downgrade by S&P.  The market losses and volatility are leaving many investors uncertain about the state of the economy and their portfolios.  We offer three scenarios to consider – base-case, worst-case and best-case – and their potential effects on the stock market.

The base-case scenario is the one that we consider most probable, and that is continued slow-growth in the near-term, with eventual normal growth resuming in the long-term.  We’ve seen two quarters of slow growth already, 0.4% for the first quarter of 2011 and 1.3% growth in the second quarter of 2011.  Slow growth quarters are historically not useful predictors of recessions.  Given our fragile economy, such slowing may induce the Federal Reserve to engage in more economic-stimulating measures.  We recognize that an offset to these growth stimulators are high, though slightly improving, unemployment, as well as global political and fiscal uncertainty.

Despite a slow-growth economy, corporate earnings are at an all time high, with expectations that S&P 500 earnings this year will be $100 per share.  This puts the stock market at about an 11.5 price-to-earnings ratio, far below its historical average of 15.  For this reason, we don’t see a catalyst for a further, significant, sustained drop in stocks.

The worst-case scenario is another recession.  Reasons for this possibility are well known:  tax uncertainty, high unemployment, nervous consumers.  General panic is not known to cause recessions, though some fear this could become a self-fulfilling prophecy.  Panic does indeed affect stocks however, which is what we are seeing currently.  Stocks are known to be a leading indicator of recessions.  When recessions do occur, the median historical market peak is about 7 months prior to the start of the recession.  But typically once you know you’re in a recession, it’s actually time to buy stocks.  In fact, the recessions of 1953 and 1990 saw stocks go straight up.

The best-case scenario is the resumption of robust growth.  The record corporate earnings may spur business and investor confidence.  There is said to be pent-up consumer demand waiting to be unleashed at the suggestion that theU.S.is still on the road to recovery.  Too, oil prices have come down considerably.  You may recall that just a few months ago high oil prices were a huge concern for the economy, as this necessary product would hamper other consumer spending.  And though theU.S.debt downgrade has spooked the stock market,U.S.treasuries, the very debt that was downgraded, have actually rallied.  This is because, in the end, investors still believe in the strength of theUnited States.

Our Chief Economist, Jim Smith, predicts year-over-year GDP growth of 1.9% for 2011 and 3.9% for 2012.  Whatever the economic outcome over the next few months, we must accept that our economy is a cyclical one, in which we experience recessions and expansions.  Long-term growth of GDP and corporate earnings leads to long-term appreciation of stocks.  Being a buyer and holder of equities gives you the ability to participate in this long-term growth.

We believe that to be a successful investor in stocks you have to accept the volatility, and the uncertainty that surrounds it.  Corrections and bear markets are part of the territory.  As an investor, it’s tempting to believe that you have the ability to guess the timing and direction of stocks, but attempting to do so is hazardous to your financial health.

Harli L. Palme, CFP®

Financial Advisor

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Don’t Get Sentimental

Today’s headline on Yahoo Finance “July Consumer Sentiment Worst Since March 2009” caught my eye.  What they are referring to is the Thomson Reuters/University of Michigan consumer sentiment index, which is a survey of consumers.  This got me thinking about investor sentiment. 

Investor’s Intelligence publishes a weekly index of sentiment derived from investment newsletters, with data going back over 40 years.  Some of our clients may be familiar with Jeremy Siegel’s book Stocks for the Long Run.  In this book, Professor Siegel used this data to derive his own index of sentiment.  He then measured subsequent stock market returns for the period 1970-2006, as well as for individual decades.  The results vary by time period, and there is no guarantee that future results will be similar to what has happened in the past.  However, some interesting relationships emerge.  I like to look at as much data as possible, so I will focus on the entire 1970-2006 period:

When sentiment went above 80%, subsequent returns over the next 12 months were negative.  When sentiment fell to 50% or below, subsequent 12 month returns ranged from +13.43% to +20.74%.

Investor sentiment is a funny thing.  The human brain is wired to do the wrong thing at the wrong time in the stock market.  I start to get worried when investor sentiment levels are high, and feel better when they come down a bit as they have recently.  Sentiment is currently around 59%.  This is down from a 2011 high early in the year of almost 80%, and up from a low of less than 30% at the recent stock market bottom in early 2009.

There is always something to worry about.  Currently it is the debate over raising the debt ceiling in the US and the continuing credit issues in some of the Euro zone countries.  We are confident that these issues will get resolved.  Something else will then come up, whether inflation or deflation, a geopolitical event, a natural disaster, or something completely unpredictable. 

We are encouraged by rising earnings and dividends in the US stock market.  Consensus earnings for 2011 are about $98 for the S & P 500.  This equates to a price/earnings multiple of about 13.4, below the historical average of around 15.  Many companies are increasing their dividends as well.  Stock prices eventually follow rising earnings and dividends, and we believe the current combination of reasonable valuations with reasonable levels of sentiment are a tailwind for long-term returns. 

Bill Hansen, CFA

Managing Partner

July 15, 2011

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I Bonds Revisited

With interest rates remaining at very low levels, there are few options for earning any sort of a return on cash balances.

 Current yields:

Schwab Bank High Yield Savings                    0.40%

1 Year CD National Average                            0.46%

5 Year Treasury Note                                   1.85%

5 Year TIPS Note                                         -0.32% (plus inflation)

10 Year TIPS Note                                        0.70% (plus inflation)

Series I Savings Bonds                                4.60% (for the next 6 months)

One thing to consider for smaller balances is Series I Savings Bonds (“I Bonds”) issued by the U.S. Government.  The new rates came out May 1, and I was surprised to see that I Bonds are currently earning an annual rate of 4.60% for the next 6 months.  Please refer to my earlier blog posting “How to Make a Little More Money on Your Excess Cash (with a Bit of Work on Your Part)” or visit www.treasurydirect.gov for a more detailed description of I Bond features.

The earnings rate for I Bonds is a combination of a fixed rate, which applies for the life of the bond, and an inflation rate that changes semi-annually (think “I” as in “inflation”). The 4.60% earnings rate for I Bonds purchased through October 31, 2011 will apply for their first six months after issuance. I Bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years.  Purchases are limited to $5,000 per Social Security Number in electronic bonds and $5,000 in paper bonds, so a couple could purchase up to $20,000 annually.

If you act by October 31, you are in effect creating a 1 year CD with a yield of at least 2.30%.  For the next six months, I Bonds will earn interest at an annual rate of 4.60%.  The inflation rate will then reset.  Since the fixed rate is zero for the life of the bond, the earnings rate for the next 6 months will be the inflation rate.  If the semi-annual inflation rate stays the same at 2.30%, the earnings rate for the next 6 months will also be an annual rate of 4.60%.  In this case, you would earn about 3.83% for 1 year after factoring in the penalty for early redemption.  Even if the inflation for the second 6 months is zero, which is unlikely, you would earn a return of 2.30% over the next year versus 0.46% in a bank CD.

What if there is an emergency and you need the money?  Since you cannot redeem the bonds for 12 months, you need to leave some liquid cash on hand.  After 12 months, a penalty of 3 months’ interest is deducted from the redemption value.  But even after paying the penalty you would still be ahead of a bank CD, and considerably ahead if the change in inflation continues at its current level. In addition, I Bond interest is exempt from State income taxes and is tax-deferred until you redeem the bond.  Also, if you buy the bonds on the last day of the month, you still get interest for the full month.

All I Bonds have the same inflation component.  The only difference is in the fixed rate that each bond offers.  If the fixed rate increases significantly in the future, just redeem some bonds and pay the penalty.  Then buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).  After 5 years, there is no penalty on redemption. 

Another possibility is a short-term, high quality bond fund.  However, these do carry some interest rate risk.  For example, a popular short-term bond fund has a current yield of 1.41% and an effective duration of 1.85 years.  This means that if interest rates were to suddenly move up by 1%, the value of the fund would be expected to fall by about 1.85%.  This would wipe out over a year’s worth of interest, making it a less attractive alternative for cash balances.

Bill Hansen, CFA

May 13, 2011

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What Does “Fee Only” Mean?

Recently, I experienced the joy of shopping for a car.  I visited a dealership from whom I purchased my last vehicle.  It was an “enlightening” experience. 

By the time the third sales associate walked into the office, I was more than ready to leave.  He attempted to counsel this ignorant girl about the virtues of a lease.  Surely, I could see how fabulous a lease was, how practical it was?  Then, he made a big mistake.  He admitted that the dealership received better incentives for leasing vehicles than selling them outright.  So, whose best interests did he really have at heart? 

When looking at financial advisors, people sometimes ask the same question.  Parsec is a “fee-only” advisor.  That term can be a bit confusing.  Any phrase with the word “fee” in it has negative connotations. 

Our firm’s income is derived from the investment counsel fees we charge.  We do not receive commissions from the trades we place.  We derive no income from recommending a particular fund or other investment.  We do not receive bonuses for referring clients to a particular custodian. 

As a result, a fee-only advisor has the ability to provide impartial advice.  This is reassuring as we learn more every day about unscrupulous brokers pushing bad investments, solely for the big commissions received.

If you are not currently a Parsec client, we encourage you to take a closer look at fee-only investment advisors.  And, if you are a client, thank you for your continued faith in us!

Cristy Freeman, AAMS
Senior Operations Associate

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Bear Market Post-Traumatic Stress Syndrome

The economic turmoil of the recent Recession, and its aftershocks, cut deep into our lives and our psyche. People are still suffering from the recession, which lasted from December 2007 to May 2009, here in March of 2011. Some of it is due to true economic hardship; other of it is due to post-traumatic stress syndrome (PTSS).

I’m not physiologist, and I don’t mean to make light of serious forms of PTSS, but I do believe that many people are suffering from a lighter form of recession PTSS. The smallest market dip has investors jittery, and I’m hearing worries once again of another recession. Investors who were able to withstand the last bear market are not so sure they’re up for it again. One sharp decline and they’re ready to bail out for good.

As an investment professional, I see signs of PTSS in myself. Other investment managers will remember the horrible, wrenching feeling of walking out of the office at the end of the day on any given day Sept 2008 – March of 2009, with the bloodbath that was Wall Street in your wake. Each day, my colleagues would mumble to each other on the way out the door, that we felt that we had just been physically beaten. Just one day of a down stock market brings back a flood of those bad memories.

The trigger for this PTSS is a volatile market. Now the storm is brewing – unrest in the middle East, oil prices spiking, the national debt load, and a hesitant economic recovery. Despite that fact that investors know that the stock market never goes straight up and that periods of decline are normal, it seems that all those invested in the stock market have an unusually itchy trigger finger, ready to sell at the slightest dips. Therefore, it’s worth a mention of the big picture: Investing in stocks is a long-term commitment, and guessing the short-term direction of the market is hazardous to your financial health.

You must choose the amount of your net worth that you are willing to commit to this asset class with this particular risk-return tradeoff. Once you choose, you cannot be shaken by short-term turmoil. Buying low and selling high inherently means that you do not sell, or allocate away from stocks, when the market is going down. It means the opposite, you buy stocks when they are low and economic uncertainty is at a peak. For the average investor it is extremely difficult to add new money during market declines, but at least by keeping your nest egg in place you avoid the money-losing pitfall of selling during a (real or predicted) decline.

Harli L. Palme, CFP®

Financial Advisor

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It’s All Relative

I see that one of our recent blogs addressed the change of benchmarks on our client quarterly reports. I thought this would be an appropriate time to be a major buzz kill and hit you up with all kinds of technical mumbo-jumbo about what makes a good benchmark. I’ll try to make it light and amusing (I don’t know about you, but I’m already laughing).

Fortunately, I just finished reading the section on benchmarks in my CFA study material (yes, I’m still working my way through those exams – this marks year MMLXXVII in my progress…). The authors of my study guide suggest the acronym, “SAMURAI” to help you remember the seven properties of a good benchmark. (For me, “samurai” brings to mind hara-kiri, a form of Japanese ritual suicide by disembowelment, which is what I feel like doing every time I have to sit down and study this stuff.)

Before I continue, I just want to point out that the whole reason for even having a benchmark is so that you can compare your portfolio’s performance to something similar. It’s kind of like the investment management version of a high school reunion – you thought you were pretty successful until you found out that nerdy guy from homeroom had invented some kind of social networking site…you thought you were out of shape until you saw what happened to the head cheerleader…

Back to the acronym. A valid benchmark should be specified in advance, appropriate, measurable, unambiguous, reflective of the manager’s current investment opinions, accountable, and investable (I’d like to mention that MS Word doesn’t recognize the word “investable” and instead recommends “ingestible.” Mmm, benchmark…).

So, the manager should choose the benchmark at the beginning of the reporting period (you know, so she doesn’t wait until afterwards and pick a benchmark that underperformed the portfolio, just to make her look good) and it should be comparable to the portfolio in terms of style (i.e., you wouldn’t want to compare a portfolio of large cap domestic stocks to a small cap emerging market index). The benchmark should have a return that is measurable and a value that is frequently updated, with clearly identified securities whose weights are known. The manager should have current investment knowledge of the securities in the benchmark, and be familiar with the benchmark’s performance, with active management accounting for differences in portfolio construction (and performance) versus the benchmark. Lastly, an investor must be able to replicate the benchmark by buying securities that mimic its composition (or be able to eat it, according to Microsoft).

If you scroll down a bit and read Bill’s blog about the benchmarks displayed on quarterly reports, you’ll notice that we’re specifying the new benchmarks in advance, and we’re doing so because they better reflect the composition of our clients’ portfolios, compared to the old benchmarks. In addition, they’re all investable (you can purchase ETFs that mimic the indices mentioned). But I wouldn’t try to eat them, if I were you.

Sarah DerGarabedian, Research and Trading Associate

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Where did the S & P 500 on my quarterly report go?

Starting in 2011, we are changing two of the equity benchmarks on our quarterly reports.  We are removing the S & P 500 and Russell 2000, and replacing them with the Russell 3000.  We will continue to display the MSCI EAFE (Europe, Australasia, and Far East) index of international companies. 

What’s the difference?  The S & P 500 index consists of the 500 largest U.S. companies by market capitalization.  Market cap is a measure of company size; it is simply the number of shares outstanding times the price per share. Since our client portfolios include small and mid-sized companies for diversification purposes, we believe the Russell 3000 is a better benchmark to use.  It will make it easier for our clients to make an apples-to-apples comparison at a glance.

The Russell 3000 is a broader market index consisting of the 3000 largest companies in the U.S. by market capitalization.  It is more reflective of the total stock market rather than only large companies.  The Russell 3000 is also what we use internally for portfolio management, including setting target weightings for various economic sectors and company sizes.  We believe it is logical for our performance reporting to reflect the composition of the index that we use when managing client assets. 

Client portfolio returns are best compared to a blend of the Russell 3000 for U.S. companies and the EAFE for the portion of the portfolio invested internationally.

We have also changed our fixed income benchmark from the Barclays Aggregate Bond Index to the Barclay Intermediate Government /Credit Index.  We believe this is a better reflection of our client’s fixed income holdings with regard to the maturities and types of securities that we purchase.  For example, the Intermediate Government/Credit Index does not include mortgage-backed securities, which we typically do not invest in.

 

Bill Hansen, CFA

Managing Partner

 

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2010 Roth IRA and Regular IRA Contributions

The deadline to contribute to your Roth or Traditional IRA for the tax year 2010 is April 15, 2011. You can contribute $5,000 or the amount of earned income for the year, whichever is less. If you’re over 50, you can contribute an additional $1,000.

Your income determines if you qualify for a tax-deductible Traditional IRA contribution, or if you qualify to make a Roth IRA contribution.

Do you qualify to deduct your Traditional IRA contribution?
 If your income is less than the beginning of the phase-out range, you qualify.  If your income is over the phase-out range, you do not.  If your income falls inside the range, you partially qualify.
  Modified Adjusted Gross Income                                          Phase-Out Range
Single, participates in an employer-sponsored retirement plan      $56,000 – $66,000
Married, participates in an employer-sponsored retirement plan      $89,000 – $109,000
Married, your spouse participates in an employer-sponsored retirement plan, but you do not.  $167,000 – $177,000
 
Do you qualify to contribute to a Roth IRA?
Single $105,000 – $120,000
Married, filing jointly     $167,000 – $177,000

 

Harli L. Palme, CFP®

Financial Advisor

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What would you say ya do here?

I was recently asked to write a summary of Parsec’s investment process, in a relatively jargon-free, easy-to-understand manner. As it happens, it is also my turn to post the blog, so surprise! I’ll be killing two birds with one stone. In much the same manner Andie Walsh created her prom dress in Pretty in Pink, I have fashioned this summary from bits and pieces of preexisting brochures and other client materials, so it may look a little familiar:

We follow a long-term investment strategy based on diversification and reduced risk. Although we create a customized portfolio for every client, our overall investment approach includes:

  • Balanced investment between growth and value, including small-, mid- and large-cap companies, with some weight in international markets;
  • Individual stocks for the large-cap portion of a portfolio (when appropriate to account size), carefully researched and chosen by our Investment Policy Committee;
  • Equity mutual funds for the mid-cap, small-cap, and international portions of a portfolio;
  • High-quality short- and intermediate-term bond funds or individual bonds for clients who require a fixed-income allocation.

We follow a bottom-up stock selection process focusing on several fundamentals including:

  • Current valuation relative to projected earnings growth;
  • Price/earnings ratio relative to the overall market and to the company’s own historical range;
  • Degree of financial leverage, avoiding heavily indebted companies;
  • Level and consistency of profit margins.

Based on our research and analysis, we have compiled a recommended list of securities. We continually monitor the prices of the securities on this list, as well as any news regarding these holdings. In addition, every security in our coverage universe is formally reviewed at least 3 to 4 times a year, and more often if circumstances dictate.

Our Investment Policy Committee meets weekly to discuss each company and vote on a recommendation. If the committee votes to sell a holding, a block trade is initiated across all discretionary client accounts so that the committee’s convictions are effected on a firm-wide basis in an orderly and timely fashion. When the trade is executed, all accounts participating in the trade receive the same price.

Investing in securities involves risk of loss that clients should be prepared to bear.  Investment risk consists of both systematic risk and unsystematic risk.  Unsystematic risk is not related to the market as a whole, but rather is associated with a specific firm or investment.  Systematic risk is the risk associated with the overall market that is not unique to any one investment vehicle. It is possible to reduce unsystematic risk by creating a portfolio diversified across many different companies and sectors.

It is not possible to eliminate systematic risk.  Macroeconomic factors such as inflation, unemployment, corporate earnings, commodity prices, and interest rates all contribute to systematic risk since they influence the prices of all risky assets. However, it is possible to lower systematic risk somewhat by diversifying internationally, since economic variables in the U.S. are not necessarily correlated with those in other countries. Of course, investing internationally exposes investors to risks related to social, political, and economic factors, as well as fluctuating exchange rates.

Sarah DerGarabedian, Research and Trading Associate

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